Green bond growth is encouraging, but investors should take care to look beyond the “green” label when purchasing bonds.
Hello this is Natalie Wright, product manager at Breckinridge and welcome to the Breckinridge podcast. Today, I am joined by Rob Fernandez, Breckinridge's director of ESG research. In the podcast today, we will focus on SASB, one of Breckinridge's most valuable relationships in the sustainable investing space. We will talk about SASB's mission and why Breckinridge is supportive of it, and there are a few exciting updates with SASB. In particular, Breckinridge President, Peter Coffin, is a founding member of SASB's new Investor Advisory Group. So Rob, throwing around a lot of acronyms here. First some background. Could you take a step back and tell us what SASB is and what its mission is?
Sure, Natalie, and it is great to be here. So SASB stands for the Sustainability Accounting Standards Board. They are a San Francisco-based nonprofit that was born out of a clear pain point for both fixed income and equity investors. Specifically, financial analysts and investors have been challenged to determine exactly which factors are most material for each industry. In other words, investors may not always know what exact ESG factors to focus on and companies may not know what factors to report on. So SASB was created in 2012 to help alleviate these issues. So SASB, as the name may imply is modeled after FASB, or the Financial Accounting Standards Board, which is the overseer of financial accounting and reporting standards. So basically, SASB's goal is to help public companies disclose material, decision-useful information, and SASB has really focused on and really uses the term decision-useful a lot in their research and writing, but they want companies to report decision-useful information to investors and they have created a full set of sustainability accounting standards for the marketplace. So these standards enable companies to disclose sustainability information alongside the financial information they are already releasing in their annual reports. And SASB's standards have been integrated into our own corporate ESG research process. We find the research to be really valuable in analyzing how a company is performing and reporting on ESG related topics.
Okay, so it sounds like SASB really tries to help both the investors and the companies, not just one or the other and really align the two, is that right?
Yes, that is right. They are really trying to link the two together to help them communicate better around sustainability topics. We will talk more about this later, but SASB's efforts to determine the material ESG factors for each specific industry may allow companies to save time and money by focusing on a shorter list of material factors, rather than a broad array of ESG issues that are out there. So they are really focusing on materiality as well as specificity in the issues they would like companies to report on. For investors, they are able to use a shorter standardized list of metrics to evaluate ESG performance rather than sift through a surfeit of reported information. So, however, it is important to note that we believe SASB supplements the Global Reporting Initiative, or GRI, standards. We think that they really can go together. GRI is the sustainability reporting framework widely used by companies today. SASB also points out that about three-quarters of its ESG factors are already discussed in companies SEC filings. So really, companies are not starting from scratch to comply with standards, these SASB standards, what they really need to do was whittle down to the most material influential ESG factors so that the quality of information available to investors is improved.
Okay, and several times you mentioned materiality. What do you mean by that exactly?
So, materiality is a really important concept that SASB has highlighted and brought forth in the ESG research space. In materiality, we are asking what ESG factors are most significant or material, or what ESG factors actually matter to investment performance. SASB talks a lot about how they are guided by the U.S. Supreme Court's definition of materiality which says, and it is kind of a mouthful, but basically that information is material if “there is a substantial likelihood that the disclosure of the omitted fact would have been viewed by a reasonable investor as having significantly altered the total mix of information made available. So, basically, if it was left out, it would alter the entire mix of information and maybe change the investor’s decision on whether to invest in a company or not. And we just wanted to highlight that an academic paper out there that was published last year talks a lot about the impact of materiality, and it is called "Corporate Sustainability: First Evidence on Materiality" by Khan, Serafeim and Yoon. We will talk more about this in a second, but the material ESG factors for each industry can differ significantly.
Okay, and I know in the world of financial modeling analysts have many common phrases to live by, if you will, one of which is to compare data or companies you need to analyze on an apples-to-apples basis. What does this have to do with SASB?
Sure, that phrase is a lot to do with SASB because SASB really is focusing on developing a standardized reporting list of metrics where companies, if they are all reporting the same metrics, can be compared company to company, really apples-to-apples comparison. So, measuring a company's ESG performance is not feasible without looking at other companies in the same industry to draw a comparison. This is because companies within an industry often face similar ESG challenges that are intrinsic, intractable to the industry, such as fracking concerns that impact oil and gas companies, workplace safety can really impact large manufacturing companies, or even climate change risks that can impact hospitals or insurance firms. By contrast, different industries have different material ESG factors, so comparing an auto company with a healthcare firm on a factor like energy management is really not prudent and it is not an apples-to-apples comparison. It makes sense to generate standards by industry, and that is what SASB has done, rather than lumping all companies together under the same standards because ESG issues can be materially different from industry to industry. So, a good example is climate risks. An issue like climate risk is going to impact all companies. SASB estimates that about 93% of all companies in US equity market are impacted by climate risk in some way, but it is not going to impact all industries the same. Data centers, for example, that are energy intensive will be affected differently than auto companies grappling with fuel emission rules. Each company should be measured against some industry benchmark, which SASB data provides. Industry benchmarks allow companies to be compared meaningfully and to give context to a company's ESG metrics. For example, an analyst may look at a food company and wonder, okay is this company’s product quality standards truly good or bad? That can only be answered by having some industry benchmark to compare to and we feel that we do identify and analyze these companies using our ESG research capabilities, but having SASB standards will make this easier.
Great, well to that end, can you elaborate on what industries SASB is covering?
Sure, so they have now issued provisional standards across 10 sectors and 79 industries, so, all areas of the economy. So they are now in a period of interaction with market participants to gather additional input before finalizing the industry standards. To that end, and to help with that process SASB has put in place a specialized analyst for each sector.
Okay, and why is all this important?
So it is really important because it kind of boils down to quality and standardization of reporting. So it is not that companies are not disclosing ESG information in their financial statements or in their corporate sustainability reports, there is lots of information that we look to in our ESG research. It is just that unfortunately financial statements generally include just boilerplate language that does not give investors enough detail and does not necessarily focus on material ESG factors for the industry the company is in. SASB's research, which has certainly been really helpful to highlight these issues shows that more than 40% of a company's existing ESG disclosures consist really of boilerplate, kind of standard language that does not give really a lot of information and only 15% of companies actually use ESG-related metrics in their financial statements to talk about these particular sustainability topics. Furthermore, these metrics are not standardized so they are not comparable across industries as we have highlighted as an issue. This boilerplate ESG language gives little investable insight into a company's ESG profile because it is so high level does not give a lot of information generally. Nonetheless, financial analysts are tasked to compare ESG performance across companies which can be difficult as we mentioned, if there if there is an absence of standards for calculating and benchmarking sustainability metrics and really, this is a problem that SASB aims to solve.
Okay and coming to a close here, I just quickly wanted to touch on something else. I know the Serafeim piece you mentioned earlier was geared to the equity markets and SASB really talks in terms of the US equity universe as well. What does SASB's work mean for fixed income investors like Breckinridge?
So SASB's work is definitely relevant for fixed income investors like Breckinridge. Their work is certainly aligned with our ESG research focus, which is all about materiality, trying to determine what are the key material issues and how they impact credit quality. ESG analysis helps us to identify risks and opportunities to credit quality that are being overlooked possibly, or not fully captured by traditional financial analysis and we have certainly found this to be helpful since we integrated ESG research into our investment process over five years ago. Through ESG, we are taking a more comprehensive view on those risks and opportunities related to corporate credit worthiness and as we found ESG is especially compatible with fixed income were capital preservation and managing risk over the long-term is critical. This is partly because risks to capital preservation are asymmetrical upside opportunities are limited if the company's credit profile remain strong or improves but downside risks are large if the credit weakens. So risk mitigation is paramount for fixed income investors and ESG is an important part of that, we certainly found that. So at Breckinridge we integrate ESG analysis into the credit evaluation of all existing and prospective corporate and municipal issuers we look at. Also to note we saw just this week, Barclays released a new study looking at corporate bonds from August 2009 to April 2016. Basically, the study showed that a portfolio tilted to high ESG-rated bonds had cumulative outperformance of about 2% versus a portfolio tilted to low ESG rated bonds. So that is looking over the past seven years and is using Sustainalytics ESG ratings, and we incorporate Sustainalytics into our corporate ESG research as well. From the muni side, studies show that bonds that fund essential public projects and have a positive impact on communities tend to have lower default rates. We think that having a standardized system for evaluating ESG performance in bond issuing companies is an important part of risk mitigation for fixed income asset managers. So we certainly feel that SASB's work and their contribution to this space has been quite meaningful.
Well, are there any other updates from SASB that you would like to mention?
Yes, there are a few more. I have three that I will highlight quickly. One is SASB's focus on education. SASB currently offers a credential called the Fundamentals of Sustainability Accounting, or FSA credential. It is a great way to learn how to best integrate material ESG and information into financial analysis and it is broken up into two sections, Level I and the recently released Level II. That is the first anything to highlight. Secondly, SASB is holding its first-ever annual conference or symposium in December in New York City and speakers include people like Dr. Jean Rogers who is the CEO and founder of SASB, as well as Mary Schapiro who is the former chair of the SEC and is vice chair of SASB. And then finally, Breckinridge is holding a lunch for clients featuring Janine Guillot who is Director of Capital Markets and Policy Outreach of SASB, for clients in San Francisco on November 15th. So, we are excited to host this luncheon and if any of our listeners are interested in attending please contact our consultant relations group. We would love to have you there.
Great, well thanks so much, Rob.We hope that you in the field have found this informative. We look forward to you joining us on our next podcast. Thank you.
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